The consumer price index is a measure of the average price of various goods and services consumed by households in America. It is intended to represent the spending by the average city-dwelling American on a typical basket of goods and services.
The CPI is similar to a stock market index in that the actual number doesn’t mean much – it’s the change over time that is worth looking at. For example if the CPI increases from 1,000 to 1,030 in one year then an economist might use that data to conclude that inflation was probably about 3% over that time period.
How is the CPI measured?
The CPI index is measured by doing surveys of families in America conducted by the United States Department of Labor (Bureau of Labor Statistics). Participants in the surveys track their spending over a specific time period – this provides the “basket of goods and services” used to measure the CPI. The actual prices of these goods and services are measured on a monthly basis by the Bureau of Labor Statistics to calculate any changes in the CPI.
Here are the 8 major groups of consumer goods which make up the CPI:
- Food and Beverage
- Medical Care
- Education and communication
- Other goods and services
Why does it matter?
The CPI index is used for several very important reasons:
- An indicator of the national inflation rate.
- Determines increases of pensions such as Social Security.
With respect to investing and financial planning – inflation is a critical component of the planning process. In order to try to estimate how much money you need in retirement as well as determine how much money your investments will provide at that time – a good inflation estimate much be used. This will be explored further in upcoming posts.
Photo Credit to bettybl.